What to do next is key for investors

After Ben Bernanke hinted in May that the Federal Reserve will probably slow down its bond buying, both the stock and bond market suffered major losses. Even gold and other commodities fell significantly in value.

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By Elliot Raphaelson

recordnet.com

By Elliot Raphaelson

Posted Jul. 21, 2013 at 12:01 AM

By Elliot Raphaelson
Posted Jul. 21, 2013 at 12:01 AM

» Social News

After Ben Bernanke hinted in May that the Federal Reserve will probably slow down its bond buying, both the stock and bond market suffered major losses. Even gold and other commodities fell significantly in value.

The stock market has recovered, but investors are nervous, not knowing when the Federal Reserve will halt its bond buying. It is natural for an investor to ask, "What should I do now?"

Joe Davis, chief economist of the Vanguard Group, recommends the following: "Focus on your overall long-term investment strategy and your asset allocation." He goes on to say that if you are looking for a certain rate of investment return, there is no free lunch. "You have to be willing to accept a certain amount of risk - and there are risks associated with all types of investments - and be prepared for volatility along the way."

If you have a diversified portfolio you are comfortable with, you don't have to take any action. It's very hard to sell at market peaks, and no one can consistently do that (unless you are writing the script for Bernanke). It's highly probable that interest rates will continue to rise. How fast, nobody knows. However, that doesn't mean you should bail out of all your bond holdings, whether your holdings are in individual bonds or bond funds.

Ken Volpert, head of the Taxable Bond Group at Vanguard, indicates that if rates increase faster than the market is predicting, bond returns could turn negative. However, he points out that a return to more positive real rates (above the rate of inflation) could create a drag on bond returns in the short term but compensate investors with higher yields over long periods of time.

If you have been investing in bond funds and reinvesting your income each month, your investment will be in bonds that pay a higher interest rate. By reinvesting your income, you are effectively taking advantage of dollar cost averaging, purchasing more shares at lower prices when the net asset value of your fund has fallen in value.

There is no question that volatility will continue in both the stock and bond markets. When there is a great deal of volatility, dollar cost averaging will work best for you. Even though I retired more than 18 years ago, I still use dollar cost averaging for both investments in common stocks and bonds.

There will be times when you want to invest more money in stocks and other times in bonds, based on rebalancing objectives. But do it gradually to take advantage of the market's volatility.

For example, if you have a lump sum to invest, rather than invest all at once, divide the sum by 12 and invest it over a year into whatever fund or exchange-traded fund you have selected.

There is no question that many investors wish they had sold a significant portion of their bond portfolio prior to the recent fall in prices.

Don't second-guess yourself. No one can predict the tops and bottoms in these volatile markets.

What you should do is ensure that you have a diversified portfolio that is consistent with your long-term objectives and with the risks you are willing to take. If you are making portfolio changes or are adding to your portfolio, use dollar cost averaging to take advantage of volatility.

Moreover, make sure any new investments you make are cost-effective. That is, select quality funds and ETFs that have the lowest expense ratios. If you expect to withdraw funds in the near term - one year or less - keep some of your investments in short-term bond funds or money market accounts to ensure you are not hurt by increases in interest rates.

Contact Elliot Raphaelson, a certified court mediator in Florida with experience in estate planning, at elliotraph@gmail.com.